2 ways to invest during stagflation

Stagflation is an economic phenomenon characterized by high inflation and high unemployment. Everyone knows that inflation has reached levels not seen in four decades in the United States, and many now fear that we are heading for stagflation.

At the press conference following the last FOMC Meeting, the Fed Chair, Jerome Powell, hinted that the unemployment rate may rise in the period ahead. So if stagflation fears materialize, what is the best way to invest during such a time?

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If history tells us something, we should compare the annualized returns during the last period of rising prices and unemployment – the 1970s. In those times, the best way to invest was to stay short equities and long commodities.

Short equities

The 1970s was a period when equities saw losses in real terms, with one notable exception – the energy sector. From this perspective, we are in a similar situation today because the energy sector is outperforming while the S&P 500 index has reached bear market territory.

Not all equity markets reacted the same, though. The key was how they managed to keep inflation at bay.

For instance, countries with an annual inflation rate of more than 10% have seen equity markets decline. On the contrary, countries that managed to keep the annual inflation rate at somewhat lower levels had seen some positive real performance.

While the S&P 500 declined by more than -20% from the highs, and the Nasdaq 100 by more than -30%, the inflation rate has not (yet) reached double-digits. As such, if inflation gets entrenched in the system, it would be very difficult for equities to recover the lost ground quickly.

Long commodities

Following the policies taken during the COVID-19 pandemic and the invasion of Ukraine by Russia, commodity prices have surged. As a result, it is the only asset class that delivered consistent gains in 2022.

This is similar to what happened in the 1970s, with a few notable exceptions. Precious metals, such as silver and gold, have outperformed back then, delivering strong real returns. But they have traded in ranges in the recent months, perhaps a consolidation before a bullish breakout.

The key lies in how long the inflation rate stays above central banks’ targets. The longer it stays at current or higher levels, the more difficult it would e to generate positive real returns in traditional financial asset classes.